Volume 8, Number 76, March 1998             

Spin-offs Create Special Law Department Challenges

Even the Easy Ones Cause Problems

By Bruce Rubinstein

A generation ago, MBA’s knew the secret of corporate success. It was diversification. Big companies followed their advice and went on a buying spree.

                They often acquired unrelated businesses because when one sector of the economy was down another might be up, and, in theory, managing a string of parking lots or an oil company was not much different than managing a record label or a film studio.

                Banks gobbled up department stores, petroleum distillers bought out chemical companies, and it was a rare Fortune 100 company that didn't at least aspire to own a junk-food brand.

                MBA’s still know the secret of success, but the secret has changed. The catchword now is focus. It turns out that managing a beverage company has little to do with managing a taco restaurant, and network television is an entirely different animal than electrical technology, even though the two enterprises depend heavily on each other.

                For in-house law departments, change is good. Having mastered the intricacies of conglomeration during that theory’s two-decade run, in-house attorneys can now busy themselves with divestment, which is at least as complicated and law-intensive. And serving one’s career interests in the context of reorganization is surely as challenging one’s prospects when several departments meld into one.

DEAD WOOD

Joel F Henning Jr., senior vice president and general counsel of Hildebrandt Inc., has consulted with many legal departments regarding spin-offs. Tax considerations, he observes, frequently drive the transaction. "Because of that they often have to be done quickly," he says, "to finish them in a certain tax year for example."

                A body of knowledge and a protocol has developed to help legal departments implement spin-offs swiftly. It includes the separation of information, often electronically stored; the division of responsibility for pending litigation and outstanding legal bills (unfinished business subject to contingency fee arrangements can be particularly troublesome); and the creating of new reporting relationships.

                "None of that is easy," says Henning, "but it is all doable. The real difficulties result from reorganization. Lawyers whose talents were tightly aligned with one business have a relatively easy time, but what, for example, do you do with specialists who worked for multiple entities?"

                According to Henning, legal departments are behind the curve when it comes to re-engineering around a spin-off. It is an ideal time to rethink the entire legal function, in his opinion, but it should be done on a realistic timetable.

                "The problem is, you have a number of people who are already feeling insecure," Henning says, "and you don’t want to run off the good attorneys by instituting big changes immediately. I usually advise waiting for a year or so before undertaking fundamental reorganization."

                There are three spin-off strategies tied specifically to the reorganization of large companies, says Aaron Williams, president of Aaron Consulting Inc., St. Louis, who specializes in recruiting in-house attorneys nationwide.

                "One, you reorganize the legal department after you get rid of the dead wood, then spin-off the new entity with a strong legal base, which may be cherry-picked further by new management."

                A second strategy is to spin-off the dead wood, then cut back what is left at the parent. There will be winners and losers in either case, but both are preferable to the third alternative, in William’s estimation.

"              Strategy three is when you don’t do a spin-off," Williams says. "You live with what you’ve got, let it drag you down, watch the emerging stars in your department join your competitors, and wait for some other company to come in and take you over. In the case of a company that needs restructuring, all service departments, including legal departments, have accumulated dead wood. It’s inevitable."

                "Dead wood," in Williams parlance, is not synonymous with loser. "They are people who don’t fit into the future of the company for a variety of reasons. Maybe their skills don’t match up any more. Maybe there are personality differences, age considerations or a need to clear out the top in order ton incentivize the bottom. The cold fact is that, many good lawyers are dead wood when the time comes to reorganize. If they are wise, they will look at it as an opportunity to revitalize their career."

A PURE SPIN

In October 1997, PepsiCo Inc. spun off its restaurant business into a new public company, Tricon Global Restaurants Inc. "We took a $30 billion company and turned it into a $20 billion company and one $10 billion company, " explains Edward V. Lahey Jr.

                Lahey remained vice president, general counsel and secretary of the $20 billion company, PepsiCo, until his retirement in January. PepsiCo’s law department now employs more than 50 attorneys, Tricon’s 20.

                Tricon controls corporate-owned and franchised fast food restaurants under its major subsidiaries: KFC, Pizza Hut and Taco Bell. PepsiCo retains its soft drink and snack food labels, which include Pepsi, Slice, Mountain Dew, and Doritos and Lay’s snack foods.

                Lahey took part in the discussions leading to the spin-off, and from the outset he advised that the transaction would pose few legal problems. "It was a pure spin," he says, "so there wasn’t much negotiating to do. We had a wholly owned subsidiary and we spun it off to the shareholders. It was not a conflict situation."

                Although the transaction itself was simple, the preparation was not. The timing was determined by how long it would take to generate adequate financial statements for shareholders. When the process began, the ownership of the ownership of the restaurant was an intertwined, world-wide structure, with one subsidiary often owning local versions of all three subsidiary restaurants.

                "That all had to be unwound," says Lahey, "and it was complicated. Primarily, it was a tax analysis. How do you take this company out from under that company without creating a tax? We used a consultant to design the project, which took two months. Implementing it took another six months."

                The rationale between the Tricon spin-off was simple says Lahey. "Focus. The grocery product business is one thing and the quick-service restaurant business is another," he says. " They take different skills and talents, they run on different cycles, and we just decided it would be better if each focused on its own business."

                The sheer number of employees working in the 29,000 restaurants and the franchise law work generated by relationships with so many franchises made the day-to-day activities of the restaurant division’ lawyers far different from those of the soft drink and snack food lawyers. They functioned in different areas of expertise and developed different skills.

                "Pepsi-Cola bottlers are franchisees, so we still do some franchise law," Lahey explains, "but our franchisees tend to be fairly large businesses. Some restaurant franchisees own just one unit, so the relationships are entirely different. And employment law is something that they have to concentrate on intensively at Tricon."

                In Lahey’s esstimation, if a law department was well run, the work doesn’t change much due to a spin-off. "The work is simply being performed for new owners," he says. "No one lost their job, and there wasn’t any relocation involved. The attorneys who worked for the subsidiaries when we owned them were located at their headquarters, Louisville, Ky., for KFC, Dallas for Pizza Hut, and Irvine Calif., for Taco Bell, and that is where they stayed."

BACK IN THE SADDLE

"I retired on Friday and went back to work on Monday," says Clifford L. Whitehill, senior vice president, general counsel and secretary of Darden restaurants Inc. in Orlando, Fla.

                Whitehill held those same titles with Minneapolis-based General Mills Inc. before that company spun off its restaurant holdings three years ago to create Darden, which now operates the Red Lobster, Olive Garden and Bahama Breeze restaurants.

                The timing of the spin-off was propitious for Whitehill. When it took place he was approaching 65, the age at which General Mills requires it’s executives to retire. "The board asked me to go down to Orlando to build up the new company’s law department and I did," he says. Thechange of venues has cut into his skiing, but other than that he has no complaints.

                The spin-off of General Mills’ restaurant business was relatively painless because the question of focus had been on the table so long that the operations were separate already. Nevertheless, logistical problems arose in all departments, including the legal departments.

                For example, all the restaurants were company-owned and operated. Thus, the restaurants generated only two types of legal activities: the acquisition and disposition of real estate, and the tasks involved in acquiring and maintaining various licenses in municipalities all across North America.

                Matters such as EEOC work concerning the 110,000 restaurant employees had largely been farmed out prior to the spin-off. Tax work was confined to sales tax matters because the parent handled all corporate filings.

                "That’s all changed now," says Whitehill. "My project has been to get the department functioning independently, which includes gaining expertise in several new areas."

                The General Mills law department employs 15 attorneys including the general counsel Siri S. Marshall. Whitehill heads a six-attorney department. There were only four attorneys doing the full-time work for the restaurants when we took over. Now, he is considering hiring two more.

                The transition was smoothed by an agreement General Mills entered with itself. "Because all the legal work other than real estate and licensing that came up for the restaurants had been handled by the parent, we agreed that General Mills would provide all the legal services Darden requested for one year."

                The bookkeeping for that service was easy because Whitehill had run General Mills law department like a law firm. He’d kept careful track of attorneys’ time and charged it back to the operations they served.

                The same billing system was employed between Darden and its ex-parent for the one-year transition period. During that time, General Mills provided complete access to all relevant files, thus minimizing the difficulties of dividing information.

                Fortunately, there was no pending litigation serious enough to cause problems, with one exception.

                "There was a very small lawsuit challenging the basis on which the stock options were divided when the companies split," Whitehill says. "It was settled quickly. Other than that, after we did the same kind of due diligence you would do with any acquisition or divestment, nothing serious came to light. There was plenty of ongoing litigation of a routine nature – EEOC suits, a few slips and falls. They stayed with Darden. Obviously the parent was still on the hook, but we agreed to indemnify them and assume full responsibility."

                Darden is now responsible for its own corporate filings and all of the other work a full-service law department provides. For Whitehill personally, the spin-off has been a big plus.

                "It’s been fun being an active lawyer again rather than a supervisor," he says. "I’ve been doing some hands-on work of a type I hadn’t done for years, financial SEC work mostly. At General Mills I was usually one step removed from the lawyer who was actually doing the drafting. Now I’m back in the saddle."

                When Whitehill accepted his new job, he told the board it would take three years to get Darden’s law department up and running properly. The three years is up in June. "I’d say we’re more or less on schedule," he says.

                The question of retirement is open at this time, and Whitehill has plenty of other business interests. In any case, he’s glad the opportunity to tun a new department came up late in his career. "It’s been a stimulus for me, that’s the best way to describe it," he says.